Guggenheim bond shop outperforms by taking fearless advantage of Fed policy

As Guggenheim Investments closes in on its five-year anniversary as a retail mutual fund shop, it continues to test the limits of bond-portfolio creativity and performance. This year through October, seven of Guggenheim's eight taxable actively managed bond funds rank in the top 6% of their respective categories, a feat not matched by any of the largest 50 fixed-income mutual fund and ETF families tracked by Morningstar. The only outlier is the $36.4 million, nine-month-old Guggenheim Total Return Bond ETF (GTO), which ranks in the 11th percentile of its peer group. As an asset management shop that was created through the 2011 acquisition of Rydex Funds, Guggenheim Investments has $204 billion under management, including $154 billion in fixed-income assets. The fact that only about $20 billion of those assets are in retail bond funds helps explain how the outperformance has been largely overshadowed by many of the bigger and higher-profile bond managers. Even though Morningstar doesn't yet apply any forward-looking analysts' ratings on any of the Guggenheim bond funds, the performance has not gone unnoticed by the fund tracker. “It's clear these funds have had a very strong record, to date, but a lot of what I would stress is that they are taking on a very different risk profile,” said Sarah Bush, Morningstar bond fund analyst. Citing the performance of the flagship $4.1 billion Guggenheim Total Return Bond Fund (GIBIX) , Ms. Bush pointed out that the portfolio is definitely marching to its own beat, which is something potential investors should understand. This year through October, the fund is up 7.31%, which compares to an intermediate-term bond category average of 5.3%. But, as Ms. Bush explained, there is no cheating the risk-reward tradeoff when it comes to investing. “The fund has a 30% allocation to asset-backed securities, and it looks pretty light on standard corporate bonds,” she said. “This is a fund that's going to behave quite differently than the Barclays Aggregate Bond Index, which has a lot of Treasury bond exposure.” The fact that almost 20% of the portfolio is below investment grade, and another 13% is listed as not rated, also sticks out as a reminder of the kind of risk the portfolio managers are taking, according to Ms. Bush. “There will be the question of how a fund like this would hold up in a sustained period of stress for the credit markets,” she said. Guggenheim's global chief investment officer and chairman of investments B. Scott Minerd, does not back away from challenges to the firm's investment philosophy. “What's different is our willingness to allocate into other areas, like a 30% allocation to asset-backed securities while our peers are averaging 5%,” he said. “We're not trying to replicate the benchmark; we're trying to get the highest absolute returns.” Mr. Minerd acknowledged that Guggenheim's fixed-income strategies would generally suffer in the event of a sudden credit crunch, including a wave of corporate bond defaults. But that's not what his team sees on the horizon. “Credit crunches have historically occurred at the end of Fed tightening cycles,” he said. Mr. Minerd's outlook is for the Fed to roll into a tightening cycle that would put the overnight rate around 2.5% by 2019, up from 25 basis points today. “We think the Fed's guidance is now fairly accurate, and a rate of around 2.5% will squeeze cash flows to the point where you will induce a recession,” he said. “Sometimes when people see our portfolios they think we're making some kind of big bets on rates. The positioning is designed to provide good performance in a rising-rate environment, but we're also trying to build a strategy that is as diversified as possible and as a result that leads to us being outside of conventional wisdom.” Looking at duration as one way of measuring bond risk, Mr. Minerd points out that at about 4.4 years' worth of duration, the core strategy still only has about 80% of the duration exposure of Barclays Aggregate Bond Index. A higher duration means the bond prices will fall more relative to rising interesting rates. Bob Rice, chief investment strategist at Tangent Capital, gives Guggenheim credit for being nimble and not being afraid to stray from the bond-fund herd. “They have been aggressive with going long various kinds of instruments that have had higher yields, like asset-backed securities, and they have picked up a lot of wind from that,” he said. “A real test will be how they do in this period now, where it appears to be transitioning to period of higher rates.” To that point, Mr. Minerd says, bring it on. “Some look at our strategies and say it's a lot of risk, we say it's just out of the consensus,” he said.